How Should a CEO's Compensation Be Determined?

CEO compensation is a complex and multifaceted issue, varying significantly between startups and large corporations. This article explores the different factors influencing CEO pay in each scenario, backed by practical insights and expert analysis.

Startup CEO Compensation

Startup CEO compensation is often contingent on the funding source and the early stage of the company. Here’s a typical progression:

At the very early stages of a startup, it is not uncommon for the CEO to work for free or with minimal compensation, relying heavily on equity ownership as a form of reward.

With the advent of angel or venture capital investment, the CEO may negotiate a base salary, which is often lower than what they would earn in a larger corporation. However, this salary is likely to be adjusted based on the level of investment, and the CEO's equity position can be diluted as additional investors join the company.

As the startup begins to generate substantial revenue, the CEO’s compensation may increase and approach market rates. Nevertheless, these salaries are still typically lower than those earned in larger corporations.

Corporation CEO Compensation

In corporations, CEO compensation is typically determined by the Board of Directors or a designated compensation committee. This compensation reflects the perceived value of the CEO to the corporation and the level of compensation required to retain the CEO effectively.

Evaluation of CEO Value

The value of a CEO is often subjective and can be influenced by various stakeholders, including the Board of Directors, shareholders, and other investors. The primary factor is the CEO’s contribution to the company’s success, which can be measured through bottom-line results, strategic alignment, and long-term vision.

Summary of Determining Factors

The CEO’s compensation in a corporation is generally guided by these key considerations:

If the company is loss-making, extravagant payouts may not align with the company's best interests.

The CEO’s compensation is often set based on the company's unique business needs, which can differ significantly from those in larger corporations.

For CEOs who are newly appointed or internally promoted, negotiations play a crucial role in setting their compensation.

Correlation Between CEO Compensation and Company Outcomes

Understanding the correlation between CEO compensation and company outcomes such as sales, growth, acquisitions, and restructuring requires a detailed examination of the CEO’s contract. Many contracts are tailored to include bonuses or other incentives tied to specific company performance metrics.

Notably, a study on Steve Jobs highlights the unpredictable nature of CEO roles. Even highly successful figures like Jobs can be fired. Moreover, studies have shown a widening gap between CEO and average worker pay, reaching a staggering 354 times greater than the average worker's salary in 2013.

These disparities have sparked ongoing discussions about capping CEO salaries. While such initiatives aim to ensure fairer compensation for all employees, there is a risk that creative accounting practices may undermine the effectiveness of these caps and create loopholes.